Croatia's economy sends troubling message to neighbouring EU wannabes

ZAGREB, May 4 (Reuters) - Ten months after Croatia achieved its dream of joining the European Union, its economy is still shrinking, sending a troubling reminder to its ex-Yugoslav neighbours that the bloc cannot promise prosperity.

EU entry requirements and membership rules are meant to ensure new entrants have strengthened their economies and institutions enough to thrive within the trading union.

For countries such as Croatia and Serbia, EU membership was also meant to help the region move on from the wars of the 1990s to shared economic development in the new millennium.

But Croatia, the bloc’s 28th member state, is its worst economic performer this year, along with bailed-out Greece and Cyprus, and there is little sign so far of local start-ups or foreign investors generating viable businesses beyond tourism.

“Only a few in Croatia seem to understand that attracting investors is nothing but a beauty contest all over Europe. Hence all the failed privatisations here,” said a Western business veteran in Zagreb.

Even Slovenia, the state best-equipped to make its own way economically when Communist Yugoslavia broke up, has struggled to let go of state ownership - notably of its debt-laden banks - despite graduating to euro zone membership in 2007. Elsewhere in the region, apart from a Fiat factory in Serbia few new jobs have emerged to replace those lost as state-owned industry rusted away.

Croatia’s Communist-era industry, including shipbuilding, largely collapsed in the 1990s. Diplomats say it was unprepared for the EU and is reaping no benefits from membership.

“There are a lot of uncompetitive companies, lots of imported goods. EU funds are not flowing. There is no planning, security, the legal system is not up to EU standards,” said an EU diplomat based in Zagreb.

World Bank data shows Croatia to be the only European country, along with Greece, whose economy has been shrinking since 2008. Croatia has shed almost 13 percent of gross domestic product in five years.

Although industrial output rose for three straight months in the first quarter, for the first time since 2009, analysts expect further decline this year and marginal growth in 2015.

“Now that Greece has growth again, we are an increasingly obvious underperformer,” said Velimir Sonje of the ArhivAnalitika consultancy in Zagreb.

“Markets see that: our (bond) yields have barely budged in the past year, while those on Slovenian and Hungarian debt have fallen sharply,” he said, referring to Croatia’s stubbornly high borrowing costs.

The latest European Commission data put Croatia at the bottom of EU fund beneficiaries, having used just 18 percent of the funds available in 2007-13.

SHIFT FROM STATE TO FOREIGN INVESTMENTS

Despite the poor outlook, the small size of Croatia’s 43 billion euro ($60 billion) economy and its relatively sound banking system, controlled by foreign parent banks, will probably keep it from becoming a major headache for the bloc.

Analysts say the European Commission’s monitoring, which has forced Zagreb to rejig the budget already twice this year, will help keep public debt in check. The bigger problem is how to develop the economy.

“Stagnation is our best-case scenario,” said Andrej Grubisic, a U.S.-educated consultant. He said 200,000 people had lost jobs in private firms since 2008 while 10,000 have been hired in Croatia’s inefficient and costly public sector.

“Without serious cuts in public spending there just won’t be a better life but the government is showing no ambition to do it,” he said.

In a marked shift from reliance on major state investments, both the government and the conservative opposition HDZ now say they must do more to attract and keep foreign investors.

“Investors are giving us a wide berth, that must be changed,” HDZ leader Tomislav Karamarko told a business forum last week. His party is pledging to cut taxes and reform the administration if they came to power.

Deputy Prime Minister Vesna Pusic promised “radical changes” and a new strategy to attract investors in the next few months.

But diplomats point to a poor reform record for both parties, which between them have ruled Croatia since independence in 1991.

In the past year, the government has failed to find buyers for flag carrier Croatia Airlines, railway cargo firm HZ, the last major state bank and fertiliser producer Petrokemija.

Investors already in Croatia praise its skilled workforce and quick access to Western Europe via roads and its Adriatic ports. But they remain frustrated by slow bureaucracy and ever-changing laws.

“We decided to invest again because we were successful. But it took a very long time to get the incentives promised for the project and we’re still waiting for some, which is very frustrating,” said Mikael Boire, manufacturing manager at Saint Jean Industries, a French car parts manufacturer.

The company completed a second investment in Croatia last year, after buying and rebuilding a small plant in 2008.

“Slovakia and Romania also have lots of advantages, incentives for new jobs. They are much more efficient and they realise what they advertise. So Croatia is a location to be studied, but it is not the only one,” he said. ($1 = 0.7212 Euros) (Reporting by Zoran Radosavljevic and Igor Ilic; Editing by Ruth Pitchford)